Why the US is not interested in carbon cap and trade with Canada

The Americans have shown zero interest in linking with a Canadian trading system. The White House has been silent on the issue, despite the opportunity provided by several joint statements on climate change by President Obama and the Prime Minister.

Imagine for a moment that you live in a condominium and that a disruptive and messy new resident wants to move in to the largest suite in the building. The new resident's arrival would mean the condo corporation can finally afford to renovate the lobby, but it also means your condo fees will go up to cover the cost of additional janitorial and security services.

Do you think you'd vote to accept the disruptive new resident? Probably not. You'd probably weigh the brief time each day spent in the renovated lobby versus the prospect of a permanent hike in the monthly condo fee.

The Americans have done similar math regarding letting Canada into their pending carbon cap and trade system, and have come to the conclusion that it's not in their financial interest to let the "messy" new resident into the building.

By the same token, our federal government has been very keen to join the Americans in a carbon trading system. In late 2009 Environment Minister Prentice maintained that "this government will press forward with a continental approach, a North American cap and trade approach."

More recent statements, coming on the heels of a repeated rebuff by the Americans, show a more flexible approach and refer to a separate "harmonized" Canadian system, while at the same time still leaving the door open for a "linked" system as well. Last month Minister Prentice offered that "we have indicated a willingness to proceed with a North American cap and trade system; we've also indicated a willingness to proceed by way of a harmonized regulatory system. But the United States government is going to have to make a choice."

So a continental, or linked, trading system with the US still figures prominently in the government's thinking on climate change. Linking simply means allowing carbon emission permits to be traded between two countries and their respective emission trading systems.

A recent study by the Pembina Institute and IISD shows that there are some very clear-cut economic advantages for Canada — and large Canadian emitters in particular — to be had by directly linking our system to the US.

The first advantage flows from the fact that the cost of emission reductions is expected to be substantially higher in Canada over the next decade, owing to the rapid expansion of the oil sands. The US, with more modest projected emissions, does not face the same carbon reduction challenges and so the cost of permits is expected to be anywhere from 30 to 50 per cent lower in the US than in Canada.

With the linking of the two trading systems Canadian permit prices come down dramatically as we enter the much larger US market. The corollary is that their permit prices go up slightly (more on this later).

The lower permit price is good news for Canada's largest emitters such as the oil sands and our coal-fired electricity generators, but it's also good news for the Canadian economy as a whole, because the GDP impact of higher permit prices is substantially softened when we shift to the lower US price.

Not surprisingly, the Americans have shown zero interest in linking with a Canadian trading system. The White House has been silent on the issue, despite the opportunity provided by several joint statements on climate change by President Obama and the Prime Minister. That's because the economic cost of slightly more expensive permits will be very real for American emitters, particularly large emitters in the petroleum sector and the electricity generating sector whose annual emissions on a firm-by-firm basis can reach millions of tonnes.

The modest benefit of having Canadian dollars flow into the US economy, as Canadians purchase permits down south, will be imperceptible except to a handful of companies who have permits to sell, but whose influence in Congress does not rival that of the oil industry. The US would also experience a slight decrease in GDP growth as a result of higher permit prices — another disincentive for the White House.

In response to the cold shoulder the Americans have given to linking, Minister Prentice has been talking about "harmonization". Harmonization is "linking lite". It means aligning Canadian and American policy without going as far as allowing permits to be traded between the two systems.

Right now Canada's policy is in fundamental "disharmony" with the pending US system. We give away permits to emitters for free; the US insists on selling some of theirs. Canada allows emitters to purchase an unlimited number of offsets; the US will impose limits on offset purchases. And in Canada almost anything can qualify as an offset; the US will require that offsets involve an emission reduction that would not have happened in the absence of the offset purchase.

The bottom line is that Canada's current policy just won't cut it, even if we're only aiming for harmonization. Unfortunately, instead of introducing a robust policy of its own the federal government is essentially doing nothing while it waits for the Americans to act.

Doing nothing has its costs for Canada. There are two things we know for certain: Canada filed a Copenhagen Accord target with the UN of 17 per cent below 2005, and we have until 2020 to meet that target. A recent study by the NRTEE shows that every year of delay in Canada's effort to meet it's reduction target entails a dramatic cost increase for business and consumers and an attendant decrease in the rate of GDP growth.

So at the end of the day doing nothing will prove to be a very costly approach for Canada, and for our major emitters in particular.

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